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Germany considers loosening the purse strings

Should Germany finally loosen fiscal policy, both growth and equity markets in Europe could get a lift – with green investments in particular benefiting. Investment strategist Lars Skovgaard Andersen surveys the prospects.

Germany is Europe’s engine, and when it splutters the entire region gets the shakes.
That is precisely what is happening at the moment – German industry is struggling and the German economy saw
negative growth in the second quarter, which is putting a damper on the whole of Europe.

The European Central Bank (ECB) has long lent a supporting hand to European
economies via an extremely accommodative monetary policy, but fiscal policy, in contrast – in other words taxes and
government spending – has not really been in focus in recent years. That could be about to change, and investors
should take note.

An obvious route in theory, a difficult path in practice German budget
negotiations for 2020 kicked off this week, and speculation is rife that Germany could potentially stoke the
financial embers with a substantial fiscal policy stimulation package.

On paper such a move looks deceptively straightforward. With limited government
debt, also in comparison to the US and Japan, for example, Germany has the financial leeway to ease and also reason
to do so, yet many doubt the country has the will. In addition, Germany’s options are limited by a number of fiscal
rules and guidelines.

The EU has rules for how large a budget deficit EU countries may have, and thus for
how much fiscal stimulation they can apply. If Germany was to be constrained by the EU rules alone, it would in fact
have ample scope to ease fiscal policy. Moreover, financing costs – in other words, interest rates – are
historically low, even negative.

Germany’s fiscal straitjacket

However, the Germans have imposed upon themselves a fiscal straitjacket that is
tighter than the EU rules:

First, Germans have the so-called black zero principle: All increases in government spending should be
financed by equivalent increases in revenues. This is not inscribed in law, but is rather a very firm principle.

Then there is the debt brake: The structural balance (the government balance corrected for economic cycle
and one-off factors) may at must amount to a deficit of 0.35% of GDP. This rule was enshrined in the German
constitution in 2011.

One could be tempted to think that the politicians could deviate from the rules, but
here we should remember that German citizens in general support the black zero, while dropping the debt
brake requires an amendment to the constitution.

German politicians get creative That being said, there are signs that
German politicians are trying to find ways in which they can step lightly on the accelerator without breaking their
own rules. Budget negotiations revealed that the government is planning to establish three new independent entities
which, among other things, will promote a number of climate projects. The budgets of the three entities will not be
included in the budget and so their debt will not form part of the debt brake calculation.

Hence, while major fiscal policy easing is difficult to implement in Germany, and
although the debt brake limits the scale of the easing, there are nevertheless signs that the German politicians are
willing to do something – which in itself is a very strong signal to the financial markets. Moreover, any nascent
economic optimism in Germany could quickly ripple through the rest of Europe.

Significance for investors

At Danske Bank, we currently have a neutral weight on European equities in our
portfolios and see a greater return potential on US equities. However, as we noted in late August in our latest
quarterly report, Quarterly House View, looser German fiscal policy is one of the events that could help pull
the European economy out of its current doldrums and lift European equities.

Hence, while we do not want to cheer too soon, we will be following events in
Germany with great interest. We also note that a German fiscal policy with particular focus on green investments
could bolster companies associated with the green transformation, where we already see an attractive return
potential.

Danske Bank has prepared this material for information purposes only, and it does not constitute investment advice. Always speak to an advisor if you are considering making an investment based on this material to establish whether a particular investment suits your investment profile, including your risk appetite, investment horizon and ability to absorb a loss

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